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Putting capital markets together

Creating a banking union and cutting public spending are two issues that have dominated the European Union agenda in recent years. Creating a capital markets union and boosting investment may come to dominate the next few.

Uniting Europe’s capital markets was a campaign promise made by Jean-Claude Juncker, the European Commission’s president-elect. It now falls to Jonathan Hill, the European commissioner-elect for financial stability, financial services and capital-markets union, to put it in place by 2019.

It is Europe’s current stagnation that has forced the issue onto the agenda. The financial crisis and sovereign- debt crises have left many EU banks’ balance-sheets in tatters, starving many companies across Europe of credit.

Often, they have few other sources. In the EU, banks account for 70% of all lending, compared to around 30% in the United States. In the US, companies can raise capital by issuing corporate bonds or shares, making private placements, or tapping investors.

Where such options exist in the EU, they are on a much smaller scale. And they are usually only national, since the free movement of capital, although enshrined in the EU’s earliest treaties, remains illusory.

Member states’ desire to retain control over their banks, insurance firms, pension and investments funds – to ensure they do not collapse but also to protect them from competition – means they are hindered from investing across borders. This prevents capital from travelling across the EU to where it is most needed and affects not only private investment but also public investment, including the hundreds of billions injected into the eurozone by the European Central Bank (ECB).

A genuine capital markets union should “cut the cost of raising capital, particularly for small and medium-size enterprises [SMEs],” as Juncker told MEPs in July. It should also allow companies to raise capital, issue bonds and invest seamlessly across the EU.

Taking action
Particularly at the second of his hearings with MEPs earlier this month, Hill outlined several actions that the EU could take to achieve this.

In the immediate future, Hill promised to increase the availability of credit information about SMEs, so as to encourage cross-border lending and investment, and to stimulate cross-border bond markets for mid-sized companies.

But creating a capital markets union will also involve reassessing existing rules. In particular, some that were adopted in the wake of the financial crisis need to be fine-tuned.

Reforming rules on securitisation, another area where Hill promised “early action”, is a case in point. Yves Mersch, a member of the ECB’s board, said in a speech in September: “The current rules lump all [asset-backed securities] together and are much too conservative. They effectively question their existence.”

Asset-backed securities were the “bad boys” of the financial crisis, says Josina Kamerling, head of regulatory outreach in Europe for the CFA Institute, a body that represents finance professionals, but it is now important to recognise that they must play a role within any capital-markets union.

Dörte Höppner, the chief executive of the European Private Equity and Venture Capital Association, argues that the EU should revisit all existing financial regulation in light of the new priority of ensuring a capital-markets union. “This is the first time that the EU is seeing [the capital markets] as a whole.”

She cites the example of new EU insurance rules, which were designed to ensure stability, but make it unattractive for insurance firms to invest their vast assets into infrastructure projects.

Another example of EU legislation hindering the free flow of capital is the addition of rules for alternative investment funds. These left member states so much flexibility in their implementation that it is harder for private equity or venture capital funds to operate across borders, says Höppner.

However, a capital-markets union is not just about knocking down barriers and deregulating, it must ensure financial stability.

Confidence in the system will be vital. Hill stressed to MEPs earlier this month that reforms must provide “investors with a high degree of protection and confidence”. This point is echoed by Kamerling: “Investors are very burnt after the Icesave and Madoff scandals,” which saw savers and investors lose billions.

One big challenge for Hill will be to unpick national rules that guarantee and protect capital markets, without draining a future capital- markets union of the confidence that it will need to operate effectively. Doing all this in time for it to have any meaningful impact on Europe’s current economic woes will be another.